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Safe harbour - Now for the nitty gritty

The innocuously named Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 (Cth) (the Bill) makes only a small number of amendments to the Corporations Act 2001 (Cth) insofar as the safe harbour reforms of Australia’s insolvent trading law are concerned.

However, the Bill’s stated purpose is much grander; namely to “drive cultural change amongst company directors by encouraging them to keep control of their company, engage early with possible insolvency and take reasonable risks to facilitate the company’s recovery instead of simply placing the company prematurely into voluntary administration or liquidation.”1

The Bill’s method in driving this cultural change is by “carving out” liability for insolvent trading in certain circumstances, rather than by providing a defence to such a claim.

Specifically, directors will not be liable for debts incurred directly or indirectly in connection with developing and taking a course of action that is reasonably likely to lead to a better outcome for the company than an immediate appointment of an administrator or liquidator to the company.

New section 588GA(2) lists five non-exhaustive, indicative factors to which regard may be had in determining whether a course of action is reasonably likely to lead to a better outcome for the company than an immediate voluntary administration or liquidation. These factors include whether the director is:

properly informing himself or herself of the company’s financial position; or

taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all of its debts; or

taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or

obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or

developing or implementing a plan for restructuring the company to improve its financial position.

It is noteworthy that obtaining advice from an appropriately qualified entity is not a mandatory requirement to obtain the protection of the safe harbour, contrary to the recommendation of the Productivity Commission in its 2015 report on business setup, transfer and closure.2

In fact, the Bill reads as if a course of action will be held to be reasonably likely to lead to a better outcome for the company than an immediate voluntary administration or liquidation if the director is (only) properly informing himself of the company’s financial position. The logic of that proposition is not entirely clear. However, the Explanatory Memorandum makes clear that the appropriate action will be determined by the size and complexity of the company in question.

Uncertainties in the new law

The Senate’s Economics Legislation Committee recognised other uncertainties in the Bill3, as highlighted in several of the submissions received by the government on the Bill.

For instance, when is a debt incurred “directly or indirectly in connection with a course of action”? Are such debts the same as, or different from, debts incurred in the ordinary course of the company’s business whilst the company is undertaking a course of action aimed at turning the company’s financial position around.4 Again, the EM suggests that ordinary trade debts will be covered, but appears to draw the line at “debts incurred for an improper purpose”.5

Also, why does the carve-out apply when a “person” takes a course of action, as opposed to the companytaking the action?6 Is the Bill sanctioning individual acts by directors that may not be ratified by the company’s board as a whole?7 If so, how will this engender insolvent companies being turned around if directors do not act in a unified manner?

Further, how does a director form the view that a particular course of action is reasonably likely to lead to a better outcome than the immediate appointment of a voluntary administrator or liquidation. This is particularly difficult in the case of a voluntary administration, which is not an end in itself but rather a gateway to several possible further outcomes (such as entry into a deed of company arrangement), many of which are unlikely to be known to a director prior to the administration.8

There are other examples of uncertainties in the Bill, but these few outlined above serve to provide a flavour of the range of matters that will need to be ironed out either in regulations or by the Courts.

The Senate Economics Legislation Committee noted several issues with the Bill raised in the various submissions received, but also noted the broad support received for the Bill overall and considered that “a number of matters raised in submissions would be best clarified in regulations accompanying the legislation.”9

As highlighted in Insolvency Infocus last week, having now passed the House of Representatives unamended and been recommended for adoption (unamended) by the Senate’s Economics Legislation Committee, the Bill will now very likely become law in the near future.

When the safe harbour will not apply

There are several express exclusions from the protections of the safe harbour detailed in the Bill. Specifically, the safe harbour will not apply to a director where:

the company has not met its obligations in relation to reporting, and provision of books, to a liquidator or administrator appointed to the company;

the company has unpaid employee entitlements (including superannuation); and

the company has not met its taxation reporting obligations.

Additionally, directors with “hope” as the bedrock of their restructure plan, and directors who are too slow to form or implement their plan, or do not change their plan to meet changing circumstances, will not get the benefit of the safe harbour.

It remains to be seen what “changes in circumstances” means in practice, and how quickly and decisively directors are required to act in order to maintain the protection of the safe harbour.

There will no doubt be some interesting test cases in this area in the immediate future.

Will the Bill achieve its stated aim of encouraging directors to remain in control of insolvent and near insolvent companies?

We expect that the change in the insolvent trading law will not be treated the same across the corporate spectrum. Small and medium companies, whose directors are more likely to be subject to personal guarantees, will continue to remain in control of their companies for longer, and delay making formal appointments, in an effort to avoid their exposure under personal guarantees. Many will shun the benefit (and cost) of obtaining advice from an appropriately qualified entity given that requirement is not mandatory to satisfy the safe harbour requirements. One suspects that many such directors will not meet the strict requirements of the safe harbour protection outlined above, or will fall foul of the various pitfalls, such as not paying employee liabilities or lodging taxation returns.

On the other hand, directors of larger corporates may well seek specialist insolvency advice earlier than they would currently on becoming suspicious of their company’s solvency. This would be a good outcome so far as the prospects of successful turnarounds of large corporates are concerned. The recent case of Channel 10 and the early engagement of specialist insolvency advisors in that instance could be an indication of the very thing the new legislation hopes to encourage.

The risk for directors of larger corporates relying on the safe harbour arises from the need to be transparent about their suspicions of insolvency (and undoubtedly to document those concerns) early in the process. If directors of large corporates also fall foul of the strict requirements of the safe harbour – again by failing to pay employees or comply with taxation reporting obligations – they will be handing to the liquidator clear evidence of their suspicion as to insolvency, and a breach of s588G.

Ultimately the success of the Bill and its stated aims may rest more heavily on whether directors and companies are willing to spend money in the ‘solvency twilight zone’ to seek appropriate advice and potentially expose themselves by being upfront and honest about the situation which the company finds itself. This will require a shift in boardroom culture in Australia and will certainly not happen overnight.

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